Efficiency, equality, and education

Unequal educational attainment seems to be a central factor in unequal economic outcomes, and in particular in the intergenerational transmission of inequality. At the same time, the real rate of return on educational investment (including the opportunity cost of forgone wages) seems to run somewhere between 7% and 10% per annum, which is a healthy rate of return. (Capital-market imperfections help explain this: it’s hard for most people to borrow against the future stream of earnings from the human capital they’d like to acquire.)

Put all that together with the likely external benefits of education, through both workplace spillovers and the political effects of mass education in a democratic system, and you get the basic liberal case for spending more money on education at all levels, on both distributional grounds &#8212 making high-quality education more widely available will help compress wage and salary differentials &#8212 and efficiency grounds (the real private return on educational investment is above any reasonable discount rate, with the external benefits thrown in as a bonus).

Yes … but.

The private return to education has two components, only one of which is part of social return. If education makes me more capable of doing a job &#8212 improves my productivity &#8212 that’s a real gain. But if it simply allows me to beat out my competitors in the job-search process by “signalling” my (unobservable) quality to potential employers, that’s a gain to me perfectly offset by a loss to them. A bigger tail is an advantage to a peacock, but you can’t make all the peacocks better off by giving them all bigger tails. In fact, they’d all gain if they could get the same reproductive opportunities at lower somatic cost by simultaneously halving the size of all their tails at once.

In 1865, finishing the eighth grade meant roughly what graduating from college means today in terms of one’s place on the educational spectrum. Does that additional eight years of sitting in classrooms rather than working actually add enough value to pay for its additional costs? I submit that we don’t know. The case for improving the quality of our educational system seems airtight; the case for increasing the fraction of each birth cohort that finishes college or graduate school seems much less convincing.

Those of us in the higher-ed biz are fortunate, in terms of our revenues, that the human-resource practices of corporate employers guarantee us a stream of customers. (We’re less fortunate in that it crowds the classrooms with people interested in the credential as opposed to the content.) But we shouldn’t confuse our (pecuniary) interest with the public interest.

FootnoteYes, the signaling system as a whole creates benefits, insofar as it helps employers solve the very hard problem of figuring out whom to hire among those seeking full-time employment for the first time. But it’s not clear that increasing the investment in that system will lead it to function better.